It’s Still A Two-Tier US Labour Market

Summary

• The latest labour market report shows encouraging reduction in temporary unemployment but little improvement in structural unemployment.
• Exit polling suggests Republicans gained unexpected support from Latinos and Black men largely because of economy and job concerns.
• The implication is clear: the Biden administration must significantly cut structural unemployment or surely pay come mid-term elections. History suggests this will be a heavy lift.

Market Implications

• Short term – The steady improvement in unemployment should benefit both equities (good economy and corporate profits) and bonds (less need for stimulus and bond supply).
• Medium term – The economy may stall as most temporary workers are recalled unless structural unemployment improves rapidly. That will pressure equities unless offset by higher productivity or continued solid corporate profits. Bonds could benefit from less inflation risk, but they could be vulnerable if there is further fiscal stimulus and bond issuance unless Fed absorbs new supply.

The US labour market posted impressive gains in October, all things considered. Despite the dual headwinds of rising Covid infections and no further stimulus, employment rose by 2.2 million. Most of the gains came from companies recalling furloughed workers. According to official data, temporary unemployment now stands at 3.2 million people, down from a high of 18 million in April.

The net result was a drop in the unemployment rate, from 7.9% to 6.9%. The ‘true’ unemployment rate, which takes into account the collapse in the labour market since March, also dropped sharply from 10.8% to 9.5% (Chart 1). As long as employers keep recalling temporarily unemployed workers, the unemployment rate will keep falling. And that is what markets are focused on now.

But the underlying reality is that there was little progress on improving structural unemployment, which remains stuck near 7.5%.^[1] Historically, structural unemployment has recovered far more slowly than temporary unemployment. Indeed, high levels of structural unemployment led to so-called jobless recoveries in the early 1990s, 2000s and post-GFC period.

The outlook for markets and the political fortunes of the incoming Biden administration will hinge on what happens with structural unemployment going forward.

A Closer Look at Structural Unemployment

A key defining feature of the Covid recession was a collapse in the pre-Covid labour force by 8.1 million workers in April. It has recovered somewhat but remains down by 4.4 million workers. In every post-war recession, the labour force never declined; it just stopped growing until a recovery started.^[2] Our working assumption is that most of these dropouts would still be in the labour force (whether employed or not) but for the extraordinary circumstances of the pandemic. The Labor Department may not view them as unemployed for arcane statistical purposes; but for anyone focused on the outlook for the economy, these people are certainly unemployed.

The latest employment report supports that view (Table 1). Total employment rose by 2.2 million people. Of this gain, 64% came from a decline in temporary unemployment and 32% from an increase in the labour force. A scant 3% was due to a decline in permanent unemployment. In fact, a closer look at the data shows that all of the employment gain since April has been due to a combination of temporary unemployed people being recalled and people entering the labour force.

Now why would employers be hiring people who aren’t in the labour force (and technically not unemployed) if there is a large contingent of unemployed people who lost their jobs? Wouldn’t it be far more difficult and expensive to entice those people to re-enter the labour force than to hire someone who is unemployed? Or should a reasonable person conclude that a lot (if not most) of the people dropped from the labour force earlier this year are really in the labour force and should be considered unemployed?

By our numbers, labour force dropouts (‘force-outs’?) now total about 4.7 million, or 2.3% of our projected total labour force of 165.5 million (Table 2). The experience of recent months shows that some are really temporarily unemployed people who will be recalled in coming months. The rest are presumably permanently unemployed. The exact split remains to be seen. Depending on your assumptions, that means the structural unemployment rate is somewhere between 4.8% and 7.6%. To put this in perspective, before Covid, structural unemployment was about 3%.

Market and Political Implications

This high structural unemployment has ambiguous implications for markets but possibly dire implications for the incoming Biden administration.

Today, markets are focused on the steadily improving labour market. Soon enough, improvement from recalling the temporarily unemployed will run its course. If structural unemployment follows the pattern of the last 30 years and proves sticky, economic growth will risk stalling unless productivity picks up. The outlook for equity markets will depend on whether productivity gains offset low labour market growth and the impact on corporate profits. For bond markets, slower growth implies less inflation (bullish) but also the potential for fiscal stimulus and more Treasury supply. Whether that is a negative could depend on the extent to which the Fed absorbs any additional supply.

Whatever happens with markets, the fate of the Biden administration will be closely tied to whether structural unemployment soon follows the improvement in temporary unemployment. One of the surprises in the election results was the support for President Trump (and down-ticket Republicans) from Latinos, Black men and non-college educated women. Their primary concern was apparently the economy and jobs, and they believe Republicans can deliver on this better than Democrats.

The implication is clear. The Biden administration must issue a clarion call that addressing structural unemployment is a top priority, and it must find policies that can do so. Otherwise, midterm elections will most likely not go well for Democrats.

1. We define structural unemployment as permanently unemployed plus people in between jobs or reentering the labour force. ↑

2. The Labor Department defines the labour force as employed people plus unemployed people. To be counted as unemployed, one must have been actively looking for work in the past four weeks. ↑